India’s smaller private banks face a dual threat—competition and consolidation. This became a little more real earlier this month, when Parliament amended a law that will allow the central bank to supersede bank boards. The Reserve Bank of India (RBI) had wanted this safeguard before issuing new bank permits.

Among these smaller lenders are Dhanlaxmi, Lakshmi Vilas Bank Ltd or LVB (Tamil Nadu), Catholic Syrian Bank Ltd or CSB (Kerala), Ratnakar Bank Ltd (Maharashtra), Tamilnad Mercantile Bank Ltd (Tamil Nadu), Development Credit Bank Ltd or DCB Bank (Maharashtra) and City Union Bank Ltd (Tamil Nadu), each of which have assets less than Rs.40,000 crore, and together account for about 1.4% of the country’s Rs.70 trillion banking sector.

Pressure to merge

These banks, which haven’t been able to improve their long-term performance, will need to induct long-term investors, said K.R. Ramamoorthy, a banker for 40 years and a consultant to the World Bank on the financial sector. “If they are unable to do so, pressure to get merged will mount, especially once investors are given more powers,” he said. “Weak leadership, skill-set related issues and asset quality will force some of the smaller banks to get merged.”

Ramamoorthy is referring to the ceiling on the voting power of investors in private banks being raised to 26% from 10% as part of the amendment to the banking law.

Much of the trouble these lenders are in can be traced to their origins as community-based banks. But, at least one expert said, a recovery wasn’t wholly impossible.

“The reasons why things went wrong with some of these banks include their expansion strategies, a cultural disconnect between the main stakeholders and the new management, and associated imbalances in their cost structure,” said Akeel Master, partner (financial services) at consultancy firm KPMG India.